Start-up Nation

McWilliams said, “The big idea is not to attract only U.S. capital and commercial know-how, but to suck in entrepreneurs from all over Europe. At the moment, Europe has huge reservoirs of scientific talent, but a very poor record at creating start-ups. The question many investors ask is: where is the European Google? It’s a fair question. In the next ten years, what if that European Google was set up here using Irish and European brains and U.S. capital? That is the prize.”¹⁶

Yozma provided the critical missing component that allowed the Israeli tech scene to join in the tech boom of the 1990s. But in 2000, the Israeli tech sector was hit by multiple blows at once: the global tech bubble burst, the Oslo peace process blew up into a wave of terrorism, and the economy went into a recession.

Yet Israel’s start-ups quickly adapted and rebounded. During this period, Israel doubled its share of the global venture capital pie with respect to Europe, growing from 15 to 31 percent. This growth occurred, however, within a tax and regulatory environment that, while favoring technology start-ups and foreign investors, did not offer the same support to the rest of the economy.

For example, while a technology start-up could attract financing from numerous sources, anyone trying to launch a more conventional business would have a lot of trouble getting a simple small business loan. Israel’s capital markets were highly concentrated and constrained. And a particular industry that would seem to be a natural for Israel—financial services—was prevented from ever getting off the ground.

In 2001, Tal Keinan graduated from Harvard Business School. “Many of my friends who were going off to work on Wall Street were Jewish, and it struck me that the Jewish state doesn’t have such an industry. When it came to managing investments, Israel was not even on the map,” Keinan said.

The reason was government regulations. In venture capital, Keinan discovered, “the way the regulatory and tax regime was set up here, you could essentially operate as though you weren’t in Israel, which was great, and it created a wonderful industry. The government basically kept its hands off of venture capital.” But, he adds, “you couldn’t do anything outside of venture capital in any meaningful way. You weren’t allowed to take the performance fees on any money you managed, so you could forget that entire industry. It was a nonstarter.”¹⁷

The asset-management business has a simple model: firms receive a flat management fee of about 1 to 2 percent of the money they manage. But the real upside is in performance fees, which are typically 5 to 20 percent of the return on the investment, depending on the firm.

Until January 2005, it was illegal for Israeli money-management firms to charge performance fees. So not surprisingly, there was no industry to speak of.

The change came from then finance minister Benjamin “Bibi” Netanyahu.

With Prime Minister Ariel Sharon’s backing in 2003, Netanyahu cut tax rates, transfer payments, public employee wages, and four thousand government jobs. He also privatized major symbols of the remaining government influence on the economy—such as the national airline, El Al, and the national telecommunications company, Bezeq—and instituted financial-sector reforms.

“In the sense that he tackled the stifling role of government in our economy, Bibi was not a reformer but a revolutionary. A reform happens when you change the policy of the government; a revolution happens when you change the mind-set of a country. I think that Bibi was able to change the mind-set,” said Ron Dermer, who served as an adviser to four Israeli ministers of finance, including Netanyahu.¹⁸

Netanyahu told us, “I explained to people that the private economy was like a thin man carrying a fat man—the government—on its back. While my reforms sparked massive nationwide strikes by labor unions, my characterization of the economy struck a chord. Anyone who had tried to start a [nontech] business in Israel could relate.”¹⁹ Netanyahu’s reforms gained increasing public support as the economy began to pull out of its rut.